Chile gets ready for index inclusion

By Jan Dehn, head of Research at Ashmore discusses Chile, which is consolidating its domestic government bonds into larger, more liquid issues in order to qualify for index inclusion.

In a world of very low yields and a growing share of passively managed portfolios, belonging to an index has distinct advantages. After all, passive investors will literally invest in anything provided it appears in an index. Smarter issuers in Emerging Markets (EM) are taking advantage of such simplistic investment practices.

Chile is the latest EM country to spot the opportunity. Following wide-ranging consultation, the Chilean government appears to have understood that Chile’s exclusion from the main EM local currency fixed income indices is not to its advantage. Chile has been excluded from JP Morgan’s GBI EM GD index, because the index provider deems that Chile’s bonds are too small and numerous for investors to be able to replicate a benchmark index of these securities.

Chile has now begun to address this problem, starting with a major change to the size and frequency of its auctions of government bonds and central bank paper. The first of these new auctions – CLP 450bn 5-year central bank paper – was well received by the market with a bid to cover ratio of 4.2 times and a cut off yield in line with the yields in the market ahead of the auction. The next auction will involve CLP 755bn (USD 1.2bn) of 10-year Treasury paper.

Over time, the new larger benchmark issues will likely replace the myriad of smaller, illiquid bonds to pave the way for Chile’s inclusion in the GBI EM GD This makes enormous sense, in our view. Beyond the ability to tap passive money, Chile will benefit from its status as a safe-haven country within the Latin American region.

In other words, during periods of risk aversion investors will increase exposure to Chile’s bonds. Since bouts of risk aversion often coincide with lower prices for commodities, which matters a lot for Chile, the safe-haven bid will usefully relieve pressure on Chile’s current account during such events. Other EM countries that already have or are in the process of granting greater access to their local markets include Colombia, China, Russia and India.